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Wither Occupational Pensions?
Sally Wheeler
Professor of Law,Queen’s University of Belfast
Copyright © Sally Wheeler 2006. First Published in Web Journal of Current Legal Issues.
Summary
This paper examines occupational pensions. It looks at the key role that such schemes play within general state based welfare provision. It examines changes within the field of occupational pensions from defined benefit plans to defined contribution plans. The significance of this change is considered in the context of current Government policy which demands that individuals take responsibility for post-retirement income levels above a very low state basic provision. The reasons for the move from defined benefit schemes to defined contribution are examined. The empirical evidence around individual financial literacy and saving for retirement is considered.
Contents
Setting the Scene – The Pensions System
One of the principal problems with any discussion of the UK pensions system or any part of it, is its fierce complexity (HL 2003). The reasons for this complexity will be become clear as the paper progresses. The focus of the paper is the changing landscape of occupational pension schemes. Occupational pensions have always been seen as crucial to funding retirement generations and so require strong regulation from the state to ensure that employees both use them to save and are able to rely on them as a vehicle for producing a return. My argument is that the state is failing to provide that regulatory steer. Employees are increasing left to make their own decisions about how to fund their retirement years in face of evidence to suggest that such decisions are almost incalculable for individuals. The move towards individualization also impacts upon traditional analyses of the role of the employee within capitalist structures.
It is important to set in context how key to the establishment of state pension provision in the post war welfare state occupational pensions were and remain. Occupational pension schemes are one of the “great welfare success stories of [the 20th] century” (1998 HMSO: 18, 65). The UK pension system can be summarised briefly as low state provision mixed with occupational private provision, or, in the language of welfare provision, a multipillar paradigm as opposed to a social insurance paradigm (Bonoli 2003). Despite recent media hype surrounding the reports of the Pensions Commission (Pension Commission 2004, 2005) and the subsequent White Paper (DWP 2006) the basic shape of pension provision is not scheduled to change. In the table below I set out the configuration of pension provision post 1978. The significance of 1978 as a date in the architecture of pension arrangements is made clear in the text which follows.
Table 1
|
1st Tier State Provision Based on National Insurance Contributions (NIC) |
2nd Tier Either State or Private Provision |
3rd Tier Purely Elective Private Provision |
| Basic State Pension |
Serps until replaced by S2P in 2002 |
AVCs into Occupational Provision, Personal Pension
or Stakeholder Pension NPSS as proposed by both the Pensions Commission and the current White Paper (post 2012) Other types of saving |
The significance of figure one below is that it demonstrates that those who have income in retirement from sources additional to state provision are considerably better off than those who have to rely solely on state provision.
Figure 1
(source Pensions Policy Institute)
Current Government policy is one of non-intervention. There is no real attempt, apart from extreme instances of, say, insolvency, to ensure that occupational pensions provide a risk free environment for retirement saving whilst Government simultaneously emphasises the importance of saving by those in employment. On an individual basis those in work are supposed to choose a savings scheme that fits their lifestyle choices (TSO 2002). As I show below employees are shunning occupational schemes and saving nothing at all or are taking out inappropriate personal private provision, employers are moving from defined benefit to defined contribution schemes and reducing their contributions as well.
In many ways non-regulation of occupational schemes has been a consistent policy of the state since 1909. An exception to this would be the interventions in the years following the Maxwell Scandal. Subsequent regulation in what I term the “aftermath of the mis-selling years” of the 1990s (Disney 1996, Black and Nobles 1998) has increasingly come to regulate the providers of private pension products and the products themselves but has applied a relatively light touch to the idea of occupational schemes. This is not to say that fiscal policy towards private pension provision has not encouraged it to the extent that it can really be seen as quasi public good but the essence of occupational schemes in terms of governance and contribution rates, unlike other private pension products, have been largely untouched. This point differs substantially from the view taken by others (Whiteside 2003, p 31-32) about the role of regulation in these years. Without rehearsing every legislative step in the evolution of pensions(Whiteside 2003, 2006; Hannah 1986) it is possible to see how successive administrations, often with ostensibly radically different ideologies in relation to welfare provision and its funding have seen an effective occupational pensions sector as a lynch pin in delivering state provision. So effective in fact that they all have taken the view that regulatory oversight would damage the sector and so should be avoided. While such caution can be explained away when the sector is thriving and delivering on “the pension promise” (Pension Law Review Committee 1993, p 10) it is not justifiable in circumstances where second tier provision is melting away.
Occupational Pensions in Context
Private occupational pension schemes had jockeyed for position with means-tested state provision introduced in 1909 and were inserted into their present second tier position really by the Pensions Act of 1925 which replaced the despised means test (this had the potential to disadvantage retired members drawing on their occupational provision) with provision based on the insurance principle. In the post war world of selected Beveridge implementation, despite the hiccup that resulted from the National Insurance Act 1946 (Hannah 1986, p 53), the governing mantra was very much that “the State ….should not stifle incentive, opportunity [sic] responsibility [through] encourage[ing] …voluntary action by each individual to provide more than that minimum for himself” (Beveridge Report, pp 6-7)). In 1963 the Treasury was busy declaring that private schemes should be encouraged as they reduced the burden on the state and might even allow for escape from the commitment to universality (Whiteside 2006, p 50). In 1959 the policy of the Conservative administration was to bolster occupational provision by effectively penalising employers who did not have a pension scheme. As I will show below this policy resulted in perhaps the golden era of the occupational pension with a burgeoning of schemes and membership rising to 49 per cent of the employed sector in subsequent years (Hannah 1986, p 67). (see fig 2)
In 1978 SERPS or State Earnings-Related Pension Scheme finally came into force as a result of the Social Security Pensions Act 1975. Legislation on these lines had been Labour party policy for some time but loss of power had prevented its earlier enactment. SERPS was financed through national insurance contributions. SERPS further demonstrates the absolute linkage of public pension provision to private occupational schemes as contracting out of SERPS was permitted by those employees who were members of an occupational scheme provided that the scheme offered a pension at a set figure or above (the Guaranteed Minimum Pension, GMP) which was roughly equivalent to the figure that would be paid by SERPS. By definition then contracting out of SERPS could only apply to those who were in defined benefit occupational schemes as only those schemes could give an income on retirement figure against which the GMP figure could be measured. The difference between defined benefit schemes and defined contribution schemes is something which I explore in more detail below.The idea behind SERPS was to end the inequality between those who were members of occupational schemes and those who were not. Those who were not in occupational schemes would now have access to an earnings related scheme. Those who were in an occupational scheme had a guarantee of at least a certain level of income on retirement – the GMP – which was incidentally the first time that occupational provision had been subjected to scrutiny as to the level of income it provided on retirement. The key point is the last one; those who contracted out of SERPS because of their occupational scheme received national insurance rebates to reflect the SERPS entitlement that they had given up. This in itself is not particularly surprising but when added to the next point becomes quite astonishing - these individuals were still entitled to SERPS benefits less the GMP which was provided by their occupational pension scheme. SERPS was also structured in such a way – on best 20 years rule etc - that it provided index linking on prices to those who had contracted out but came back in again on SERPS minus GMP. The result of this was that even those who contracted out of SERPS would still get the majority of their second tier pension (see Table 1) from the State. The State was then underwriting the success of private occupational schemes and pushing private schemes onto individuals by subsidising them against competition from the state (O’Higgins 1986, pp 138-40).
Unsurprisingly the cost to the public purse of SERPS became a worry for subsequent administrations. An increase in the number of people retiring (from 8.9 million in 1980 to 9.9 million in 1990) and those retiring with eligibility for SERPS saw spending on elderly people rise by 24 per cent between 1978-9 and 1989-90 (DSS 1990). In a combination of three pieces of legislation – the Social Security Act 1985, the Pension Act of 1986 and the Financial Services Act of 1986 the Thatcher administration took a scythe to SERPS provision (Deakin 1987, pp 138-154). The future costs of SERPS was contained by a reduction in value from 25 per cent to 20 per cent of average earnings and the ending of the best 20 years rule. The emphasis was on the expansion of the private sector and a particular sort of private sector at that. The reforms mark the beginning of the love affair with individual pension provision as opposed to reliance on collective schemes based around employment (Pierson 1995, p 71) that continues today. Although employers setting up new occupational schemes were offered a rebate against NIC, the emphasis was on the establishment of personal pensions on a defined contribution basis also facilitated by NIC rebates (Waine 1995). It was no longer possible for employers to make it a condition of employment that individuals were members of their occupational scheme. The effect on SERPS was dramatic.
Ten years after the launch of personal private pensions; 68 per cent of employees had left the SERPS scheme into contracted out provision (Budd and Campbell 1998, p 100). More significantly some 500,000 employees had left their occupational schemes and had taken out a personal pension. These pensions were of course non-contributory for employers. A significant amount of the value of the paid out occupational scheme was used to pay administrative set up charges and commission. Additionally many of those taking out private pensions either did not pay at all or did not pay for very long, additional contributions leaving their pension “pot” as it were set at the level of the minimum contribution – the rebate for contracting out of SERPS. In 1998 the Department of Social Security produced evidence that a third of people who take out personal pensions cease making contributions within three years (HMSO 1998, p 18). Set-up charges will ensure that for these individuals the value of the pension plan on retirement will be miniscule in comparison to their income needs.
Occupational Pensions in 1995
If we freeze the picture of occupational pensions at 1995 what we see is the following distribution:-
(GAD Occupational Pension Schemes 1995)
The decline that is visible from the 1979 high has continued and the membership of occupational schemes has continued to fall. In 2004 there were 9.8 million people (GAD 2004) in occupational schemes out of a working population of 25.7 million people, significantly less than 50 per cent (Pensions Commission 2005). The 2000 General Household Survey revealed that 16 per cent of fulltime employees who could participate in their employer’s occupational scheme choose not to do so (DWP 2002, p 29).
Figure 3 History of Active Scheme Membership
(GAD Occupational Pension Schemes 2003)
This pattern can be interpreted as a comment on the changing nature of industrial structures and of work life (Clark pdf). The post war years saw the nationalization of previously privately owned industries as monopolies or near monopolies in many cases. The size of these industries saw pension entitlements used as part of wage negotiations particularly during the era of wage restraint policies. In the private sector blue collar workers were often excluded from these schemes and those who benefited most were skilled or technical workers who had stability of employment. These workers were most likely to be men. The 1980s onwards saw the return of many of these industries to private hands. More women have joined the work force particularly in the public sector (Lewis 2001). The employment rate of working age men has fallen from 92per cent in 1971 to 79% in the spring of 2005. Over the same time period the employment rate for working age women has risen from 56 per cent to 70 per cent (source: Office of National Statistics). Heavy industry has given way to primarily service industries and manufacturing industry continues to relocate to production sites with lower cost regimes. Pension scheme entitlement was the province of union collective negotiations; union membership has been in decline through choice and deregulation for some time (Gall and McKay 1994). Full time employment, where occupational pension schemes are most likely to exist, while currently enjoying a period of stability, has declined in availability from the position in the 1970s. The sector by sector analysis of occupational pension provision below lends some support to this. Firm specific skills are less important in service industries and so employers no longer see the need to reward employees in the same way as they did when heavy industry dominated (Sass 1997, p 238).
Figure 4 Participation in Occupational Schemes by Industry (2003)
For both employee and employer flexibility is a key concept. Work with one employer for life is much less likely to be possible or even desired as lifestyle choices have expanded (Wheeler 2006). Below I examine the reasons that are given for the decline in availability of defined benefit schemes. One reason fits here with the story of changing work structures and that is, though hotly disputed, (Disney and Emmerson 2002 cf Ring 2002, p 558) employee mobility. Defined benefit schemes operate off final salary calculations rather than a career average salary so rewarding those who stay with a single employer. Defined contribution schemes, broadly speaking the alternative to defined benefit schemes, require, amongst other decisions to be made, an individual to decide what to do with their vested account balance on any change of employment. So, although it might no longer be the case that an individual’s pension fund remains locked into the scheme of a previous employer and frozen at the level of the final salary paid in that employment, an individual requires a particular knowledge of the investment market to be able to decide how to maximize the return for retirement on this lump sum. As I explain below what evidence there is on the investment decisions of individuals would suggest that few are in possession of the information required.
A New Form of Occupational Pension – Stakeholder Pensions
As table 1 indicates New Labour approached the problem of pension provision not by adopting the solution advocated by Frank Field, its considered “expert” in the area, of universal provision funded by a mandatory scheme across employees and employers, (those not in work were to be funded by government contributions) but by abolishing SERPS (Blackburn 2002, pp 298-310, Field 1996). SERPS was replaced in 2001 by the Second State Pension, S2P, a new scheme called stakeholder pensions and a means tested Minimum Income Guarantee (HMSO 1998). The idea behind the replacement of SERPS with S2P was to offer a contributory scheme for the very low paid. The Minimum Income Guarantee was to improve the position of the least well off pensioners. It has now been replaced by the rather more sophisticated Pension Credit. Taken in the round, this raft of reforms was effectively pushing all into relying on second and third tier support largely through commercial or at least private and personal arrangements rather than collective schemes (Blake 2000). There was little clear water between the ideology of these reforms and those made under Thatcher’s tenure (Clark and Emmerson 2003).
The desire to secure workplace based saving through occupational schemes vis the stakeholder pension was a key plank of New Labour’s pension policy as it served to send the message that those in work must save for their retirement rather than rely on what was perceived of as a cultural dependency on the state. A stated aim of New Labour’s policy on pensions was to put the foundations in place to reverse the 60:40 pensioner income dependency on the state (HMSO 1998b, TSO 2002). The primary target group for stakeholder pensions was seen as those in the “middle income groups” who were not already part of an employer occupational scheme. Middle income groups are defined as those earning between £9000 - £20000. Those earning over £30 000 a year and belonging to an occupational scheme are ineligible. (For details see the Welfare Reform and Pensions Act 1999 and supporting statutory rules.) Put simply they are a financial product, based broadly on a defined contribution scheme, provided by a cross sector partnership of Government and private sector financial institutions. Employers without an occupational scheme are under an obligation to identify a stakeholder scheme and to facilitate access to it for their employees, so there is still some vestige of an idea of collectivity. Stakeholder pensions are therefore portable. They are also voluntary and are backed by tax and NIC relief. Employees can take out a stakeholder pension with an approved provider directly or indirectly through a membership organization such as a trade union or through an employer-provided scheme. In order to qualify as a stakeholder product management charges must be no higher than one per cent. By stipulating that the management charges must be this low, two possible consequences could result, one positive and the other less so. The charges for personal pension products generally could be forced down but also stakeholder funds could be invested in low maintenance tracker funds offering a poor return. Although costs are kept down there is no requirement of a minimum employer contribution as figure 4 shows:-
Figure 5 Percentage of Employers providing access to and making a contribution to stakeholder pensions
The Pensions Commission in its first report of October 2004 did not speak kindly of stakeholder pensions:-
“Stakeholder Pensions ha[ve] had only limited effect. The vast majority of small company Stakeholder schemes are empty shells with no contributing members. Sixty-five percent of companies with 5-12 employees have nominated a stakeholder supplier, but only 4% are making contributions. And the “new premiums” which have gone into Stakeholder Pensions include a large element which previously was going into other types of pension scheme.” (Pensions Commission 2004, Mann 2005)
The Marketization of Welfare
Instead of analysing the reasons for the failure of its stakeholder pension policy the Government has continued to insist that individuals must take responsibility for their own pension saving. There has been surprisingly little debate around the structure of pension provision and relatively little suggestion of innovation (Banks and Emmerson 2000). The advocating of “responsibility” is symptomatic of post 1997 welfare policy and the so-called Third Way in general. Four core values have been stressed: the holding of rights mean the accepting of responsibilities, individuals are equal, individuals are entitled to equality of opportunity and not equality of outcome, and the state is an enabling institution not a providing institution (Taylor-Gooby and Larsen 2004: 62). Despite articulating the importance of caring responsibilities for familial others and stressing the role of care in a wider political sense to denote the importance of voluntary work and active citizenship the UK Government has continued to prioritize market relationships (Duncan and Williams 2002).[1] The status of paid worker as the status to be desired and achieved is reinforced by policies such as the New Deal (Levitas 2001) and the restructuring of taxation and National Insurance contributions to make sure that “work pays”. The triggering of welfare benefits by market participation exacerbates if not causes the juggling of care responsibilities around work by pushing those who already have responsibilities in this area into the workplace to take employment which is low grade and poorly waged and stigmatizing those who can not participate or who choose not to.
The marketization of pension provision sounds in the market centred neo-liberal policies (Rose 1999, p 146) of early 1990’s governments. This stance is softened somewhat now by more social democratic regimes, but these regimes themselves are driven to welfare reform not least by the rising costs of welfare provision (Esping Anderson 1999, pp 76-77). Welfare regimes face being funded by a numerically declining and ageing work population. This is the product of changing demographics. Life choices are now available to women in terms of control over fertility and life expectancy is increasing. The move aware from welfare based expectations to reliance on personal savings has continued despite shifts in the political ideologies driving governments. Whether we see what is occurring as neo-liberal individualization being enacted or as social democratic policy struggling to cope with demographic change one thing shines through and that is that suggestions of redistribution of wealth through the pension system are dead.
To an extent this is the beginning of another story but it does impact on the pensions debate as the effect of structuring the economy in this way is to provide particular sorts of workers who perceive the risks that face them in a particular way. In other words despite the urgings of Government to take responsibility for their own post retirement income provision by selecting from the choices I outline below they are likely to prioritise other needs. Later in the article I draw on some of the literature around household financial decisions to illustrate this point. These choices exist in a frame that makes certain assumptions about the individuals on which they are being imposed vis that they are active rather than passive about their future income, that they are educated about their future financial position and that they are financially literate enough to make a choice about their financial future (Skinner and Ford 2000). Risk is mediated not through the provision of collective welfare but placed on the individual using the motif of responsibility. It is the responsibility of the individual to enter the labour market taking advantage of government sponsored schemes for training or employment if necessary (Finlayson 2003, p 189). Caring responsibilities and ideas of active citizenship encouraged in other fora are presumably to be fitted around participation in employment. The individual is thrust into the spotlight in a way that is different from the market individualism of previous eras of capitalism.
Then market individualism followed the dominant narrative of modernity. Now the individual has to balance opportunities from within a climate of personal autonomy. As Giddens expresses it
“the self becomes a reflexive project........Individuals cannot rest content with an identity that is simply handed down, inherited, or built on a traditional status. A person’s identity has in large part to be discovered, constructed, actively sustained” (Giddens 1995, p 82, Beck 1994, p 14).
This can mean a discovery of race, sexuality, or perhaps unfulfilled dreams. More distressingly at a macro level the journey towards individual identity may fuel nationalistic politics and territorial disputes (Bastow and Martin 2003, p 93). On one level the search for identity can generate a certain amount of excitement for the individual, on another it can cause a good deal of pain and consternation – “we should never be too sure about what we think we are because it could easily happen that, at that precise moment, we are, in fact, something completely different” (Saramago 2002, p 98) . It places the individual in a position of making choices and decisions in a world in which the opposing diametric of flexibility or uncertainty, depending on one’s situation, reign supreme. This is illustrated by the material I present in the next section.
The Move from Defined Benefit to Defined Contribution
Thus far I have sought to demonstrate that occupational pensions have always played an important role in state planning around retirement. Post 1997 policy maintains this and seeks to spread the gospel of occupational provision through stakeholder pensions. Despite the failure of this policy it is clear that the intention is that individuals are to become “lifestyle managers” rather than passive subjects (Deacon 2002). Choice is compelled for individuals and there will be serious consequences for those who do not make the right choice. Individual choice is dependant on the volunteerist nature of the firms that employ them. As the legislative structure that surrounds pensions currently exists firms can simply decide to close their defined benefit schemes and offer a defined contribution schemes instead. Individuals then move, through no choice of their, from the certainty of a final salary scheme to the uncertainty of individualised market return.
In simple terms in a defined benefit scheme the risk of losses and surpluses accrues to the scheme sponsor, the employer, in a defined contribution scheme the amount that has to be saved to achieve a particular income on retirement has to be decided upon by the individual. Defined benefit schemes are not entirely risk free for the employee. There is a possibility of under-funding or of firm insolvency. The recent intervention of the Parliamentary Ombudsman (TSO 2006) demonstrates both that these risks exist and that the consequences of their occurrence is often catastrophic for the individual (Ring 2005, Hyde and Dixon 2004) but I would suggest that they pale considerably as risks when placed next to the decisions that an individual has to make when in a defined contribution scheme. There are two decisions. First what income will be necessary on retirement to attain the desired standard of living and second what investment pattern to choose in order to generate this income. Given the dependence of retirement welfare provision on the occupational pension system it seems strange or perhaps even negligent of the present administration not to intervene to stem the tide of change that has been sweeping occupational pensions, the converse of this is that intervention by the state takes away the element of individual choice, that itself rests on the assumption that the individual is in a position to make this choice.
Additionally the move from defined benefit to defined contribution schemes has the potential to reconfigure shareholder capitalism. The creation of a class of worker/shareholders goes to the heart of the debates about short-termism and shareholder-driven notions of value (Fung et al 2001). It raises the question of in whose interests institutional investors operate and to whom they are accountable (Ghilarducci et al 1997). The traditional analysis of the firm sees the employment interest categorised as one that is exposed to risk as a fixed claimant for wages only and as one that has no other claims of immediate substance outside the employing firm. This is contrasted with shareholders who are seen as residual claimants exposed to risk across the market place. Defined contribution plans in particular expose employees to the risk of market performance in relation to their diversified portfolio thus eliding the difference in interests. This too is the beginning of another story but in the context of this paper it serves to point how fundamental occupational pension provision not only to post retirement income but also to capital market structure and behaviour (Proffitt and Spicer 2006).
The figures below (6 and 7) make it clear that employers have used the move from defined benefit schemes to defined contribution schemes as an opportunity to reduce their contribution to post retirement provision. Employees are also making substantially smaller pension contributions in the era of defined contribution schemes than they were when defined benefit schemes were the norm. The effect of this is that there is a much smaller amount of contribution capital accruing to each individual’s pension plan from which retirement income must be generated. This creates a knock-on effect of future dependency on state welfare provision.
Figure 6 Contribution rates of Employers and Employees to Occupational Pension Schemes
Figure 7 Average Contribution Rates by Scheme Type
The Trajectory of the Switch from Defined Benefit to Defined Contribution
The years from 1995 onwards have seen a large drop in the numbers of open defined benefit schemes in the private sector and a consequent rise in the number defined contribution schemes. (See the First Report of the Pensions Commission issued in October 2004; Pensions: Challenges and Choices. The annex to chapter three of the report suggests that there has been a 60 per cent drop in defined benefit schemes since 1995 and predicts a potential further fall of 20 per cent.) If we quantify the level of change uses the figures provided by the Government Actuary Service we get the following picture:-
In 1995 there were 5.2 million people contributing to private sector DB schemes
5 million of these were in open schemes and 0.2 million were in closed schemes. In 2000 there were 4.6 million people contributing to private sector DB schemes 4.1 million of these were in open schemes, 0.5 million in closed schemes.On GAD’s own figures then this implies a closure rate for Defined Benefit schemes of 16 per cent between 1995 and 2000. It seems that the closure rate for defined benefit schemes has gathered pace since 2000. There have been numerous surveys, all using slightly different methods of calculation, that point to this. While the exact figures reported by each may not be the most robust the general trend that they illustrate is the following:-
Pensions Commission survey of FTSE350 company accounts to year end 2002 – 60 per cent of active DB scheme members were in closed schemes
Employers’ Pension Provision Survey 2003 – number of open DB schemes has fallen 33 per cent between 2000 and 2003 (20 or more employees)
CBI/Mercer survey in 2004 suggests a 41 per cent DB schemes closure rate to 2004 with a projected 10 per cent closure over the next year.
Figure 8 Defined Benefit and Defined Contribution Schemes by Establishment Date and Number of Employees
In addition the stories of pension fund closures in companies such as British Telecom are filling publications such as the FT and the Economist on a fairly frequent basis.
Explanations for the move from Defined Benefit to Defined Contribution
In the text above I have touched on two possible explanations for the decline first in occupational pension participation and second for the movement from defined benefit to defined contribution; changing industrial structures and job mobility. There are other factors which, in common with these two, point to external macro economic factors as being the reason for the switch. The argument is this:- corporations realised that factors such as increasing life expectancy of beneficiaries and the effect in terms of cost of regulations such so those introduced by the Social Security Act 1985 on index linking, the potential impact of the Pension Act 2004 and the protection fund for under-funded schemes that it introduced (Cass 2005) left defined benefit schemes with promises that could not be fulfilled. There are other regulatory factors that could be cited here such as the introduction of new accounting standards for the reporting of the funding arrangements for occupational pensions such as FRS 17 and changes to the corporation tax regime which altered the amount of tax relief that could be applied to their funds’ dividends. If we add to this the use of supposed pension surpluses to provide generous early retirement provision during the recessions of the early 1980s and early 1990s and the peaks and troughs of the equity market (Langley 2004) then it looks very much as though the decision to switch scheme types is an informed decision made for sound business reasons.
However when subjected to critical examination none of these economic factors taken collectively or singularly would appear to provide a completely convincing explanation. There has been a gradual increase in longevity over the last twenty years. This is surely something that careful planning could have overcome. The majority of schemes closures, as the figures tracking the switch set out above demonstrate, have occurred post 2000 and yet the equity market was been unstable throughout the 1980s and there was a crash in 1987 (Bridgen and Meyer 2005). This did not provoke mass scheme closure. Changing regulation of fund accounting and the restructuring of taxation is not normally sufficient to spark a radical change in behaviour. Research that has looked at the effect of financial regulation on corporate behaviour has shown that corporations invest in developing avoidance tactics and devising evasive compliance strategies (McBarnet 1984 and McBarnet and Whelan 1991). Anecdotal evidence from Towers Perrin (Towers Perrin 2004), a large business support enterprise offering services from corporate investment consultancy to human resource management consultancy, indicates that the impact of FRS17 was a factor in switching schemes for only 24per cent of the employers surveyed.
The clustering of scheme closures could be explained by herd behaviour (Banerjee 1992). While the actual modelling of herd behaviour may belong within micro-economics, at a conceptual level its tools for understanding imitation in firms are relatively straightforward (Lieberman and Asaba 2006). Two broad categories of explanation exist within the literature – information based theories of imitation and rivalry based theories of imitation. Information based theories suggest that firms follow other firms that they perceive, rightly or wrongly, to possess superior information and rivalry based theories suggest that firms follow each other either to respond to or to limit competition. These two categories do not necessarily work in isolation and imitation behaviour may occur as a combination of both information and competition. The rise and fall of the dot.com bubble is a very good example of imitation behaviour that draws on information and rivalry. Many businesses rushed to join the world of internet based business only to find that this was an innovation that was not suitable for their product. Their enthusiasm was based on following others and competing in innovation. Within this paradigm there are “fashion leaders”; those firms who it is supposed have superior information (Bikhchandani et al 1998) based on size or longevity in the market.
If we consider imitation or herd behaviour in relation to pension schemes then emerging as “fashion leaders” are those long established and large PLCs and other bodies that closed their defined benefit schemes to new entrants in the late 1990s, for example Sainsburys, the Abbey National and Age Concern. Crucial to imitation are informal contact situations through which Information can cascades. Information cascades when fashion is followed without recourse to personally held or acquired information (Hirshleifer and Teoh 2003). Informal networks and contacts between firms could exist in the medium of trade fairs, trade associations and business dinners (Bridgen and Meyer 2005, pp 778-9). A more significant source of informal contact is investment consultants. Figures 9 and 10 below demonstrate the value of pension fund assets and the relatively small club of investment consultants that act as advisors to scheme trustees (Kakabadse and Kakabadse 2004, pp 14-15). Just four firms provide investment consultancy advice to 70 per cent plus of funds with assets of over £25 million pounds. The Towers Perrin survey (Towers Perrin 2004) reports that 39 per cent of employers surveyed switched their pension scheme to match trends in the market ie among other firms.
Figure 9 Pension Fund Assets as a percentage of GDP
Figure 10 Market Share for Pension Advisers, by size of Pension Scheme (%) 1999
(Myners Report 2001, p 65)
Given the information produced by the Myners Report (Myners 2001, p40) on the lack of training given to pension fund trustees, a position not unique to the UK (Conley and O’Barr 1992), it seems likely that the trend in switching from defined benefit to defined contribution schemes is driven by the advice of a small number of investment consultants. The only consolation in this is that decisions made as a result of herding are fragile and liable to reversal on the receipt of negative signals (Bikhchandani et al 1992). One such negative signal could be a change in investor behaviour as a result of pension fund capitalism (Ring 2003, p 73).
Financial Literacy
In the era of defined contribution occupational pension schemes investor activism is dependant upon the financial literacy of the individual. The need for financial literacy has its first impact in relation to individuals in defined benefit contribution schemes in the decision around how much of their present salary to put into the various options offered by their scheme to produce a viable retirement income. An individual employee needs to know how much income will be required in retirement years to maintain a particular living standard. The various options available within the scheme have to be evaluated and then monitored continuously against performance. Individuals have to be able to make decisions about whether to opt for long-term investment growth or higher short-term return (Byrne 2004). These decisions require a life plan and an idea of risk evaluation about events in the life course, such as how long children will be financial dependant for, the likelihood of early death or job loss, and about other financial issues such as mortgage finance and repayment. The advantage of a defined benefit scheme is that while these life course events may still occur the one (almost, see text above on insolvency and under funding risks) certainty is the level of lump sum available on retirement and income levels thereafter.
This idea of individuals being exposed to “risks”, their calculations of these risks, the extent to which certain responses to risk should be encouraged through public policy and the assumptions that policy makers make about attitudes to risk is part of a much larger debate within the fields of social policy (Taylor-Gooby 1998, 2000) and increasingly behavioural economics (Bernartzi and Thaler 2002). There are two related points to be made here. One is to point out that despite its apparent discovery of behavioural economics and the effect that it has on models of personal saving in May of this year (DWP 2006), the present Government has funded much of the work in the UK (all cited in Rowlingson 2002), that has highlighted the poor choices that are made by individuals in relation to savings and vehicles for saving in recent years. The second is to summarise this work.
Rowlingson (2002) draws together this work which is both qualitative and quantitative. It provides an evidence base for much that we might have thought already from anecdotal evidence. It seems that within the life cycle a three stage process exists in relation to financial planning. For those in their 20s and early 30s current consumption is the most pressing financial objective, the next stage involves prioritising mortgage payments. Only from late 40s onwards is pension planning and finance an issue. This would suggest that minimum contributions only will be made to employer defined contribution schemes until the final third of working life. If we add to this evidence on attitudes to saving the evidence that individuals find not only the calculation of risk difficult but the understanding of financial products and how these products do or do not hedge particular risks or provide particular benefits (Burchardt 1997) then the position becomes more serious.
Conclusion
The majority of Individuals are not in a position to take advantage of the welfare choices that are reposed in them. Occupational pensions could provide a buffer for many people against the consequences of making “the wrong choice” or no “effective choice”. State design of welfare provision has long been conducted around the assumption that occupational schemes would provide the majority of income for those eligible for them in retirement. This is no longer the case. The move from defined benefit to defined contribution schemes exposes individual employees to the risks of the market in a way not seen before. Government seems reluctant to acknowledge this move or its consequences.
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[1] See for example the Speech of Gordon Brown, Chancellor of the Exchequer, at the launch of the Charity Bank, 17th October 2002. There Brown’s “vision of Britain” included networks of local volunteers supplying services that were previously supplied by the state. In 2004 Brown designated 2005 as the Year of the Volunteer. Two of the aims of this initiative were to increase the number of volunteers and increase the number of volunteering opportunities.